Beijing hosts its annual Auto Show this weekend, and many of the global industry’s top executives (including Carlos Ghosn) are here to assess the trends and potential in what became, this past year, the world’s largest auto consumer market. The growth in auto sales in China is truly astounding — as Andrew notes in his article, 2009 sales were up 48% over 2008, and for the first three months of this year, sales are up 80% over the same period last year. Some critics, including Gordon Chang, have argued that these numbers are not what they seem. Now, everybody who reads this blog knows that I’m perfectly willing to contest high-flying Chinese economic numbers that I think are inaccurate or misleading, and I’m particularly skeptical of claims that domestic consumer spending has taken over as the new driver of Chinese growth. But I bought a car here late last year, and I can personally attest that the showrooms we visited were filled with eager buyers. These days, the Chinese are almost as crazy about buying cars as they are about buying real estate.

I’ve also visited several auto manufacturing plants around China, and everywhere I go, the managers are extremely optimistic about future growth. For foreign companies in particular, like GM and Ford, the Chinese market is the one bright spot in an otherwise gloomy landscape. Even with companies like BMW planning to double capacity in the next two years, most analysts think there will be plenty of demand for all those new cars.

But as Andrew points out, the real concern for carmakers isn’t a lack of demand, it’s an overabundance of competition. As he notes, China’s auto industry in highly fragmented. I can’t even recognize all the brands of domestic-made cars I see on the streets here in Beijing. Andrew writes that:

Manufacturers are piling into the small and midsize car sector, where already thin margins will only get tighter as the price of steel and other inputs rise. Companies are likely to find themselves unable to pass those higher costs on as sales growth slows. Even with sales still robust, J.D. Power notes that general price levels have remained flat so far in 2010.

This last comment got me thinking back on my own experience buying a car in China. When I went to the dealer, I was all prepared for the regular ritual of no-holds-barred negotiation so familiar to American car buyers. I gave the man my price, and said I was either ready to buy at the price today, for cash, or walk. When he demurred, I told him to call his boss and ask whether he wanted to sell a car or not. I might as well have been haggling with a brick wall. They cut maybe US$100 off some of the extras, and told us take it or leave it. We took it. I figured at the time that it was just a seller’s market — they had so many buyers, they didn’t care if I walked out the door. That may well be the case. But now I wonder whether their margins were so thin they couldn’t really afford to budge. Or did I cave too easily? If anyone has any insight on this, from a buyer’s or seller’s perspective, I’d love to hear from you.

Andrew second article, on futures trading, is also worth a look. “Last week,” he writes, “China launched its first domestic stock-index futures contract, based on the CSI 300.” I had been aware of this development, and had even been asked to comment on it in the media, but besides observing that this is one more step in the development of China’s capital markets, I wasn’t sure what to say. Andrew has some useful insights to share on the likely impact of this new instrument. He writes:

The clearest benefit is one that regulators plainly had in mind: Giving Chinese investors a way to bet against the market. Currently, short sales are illegal, so investors can only sell shares they already own. With investors able to sell short, volatility should be lower in the long run.

Andrew points out that China’s CSI 300 Index ended 2009 with 100-day realized volatility of 36.1%, compared to 16.4% for the S&P 500, 21% for the Eurostoxx 50 and 22% for the Nikkei 225. Enabling index futures trading could help reduce that gap. But it could also boost volatility in times of crisis:

When extraordinary unexpected events occur, futures equip investors with enough liquidity and leverage to drive prices much faster than stocks. That could simply mean stock prices head where they are going anyway, just more quickly. But it could also put markets under extra strain at times of panic.

He notes that, in the absence of futures trading:

When stocks were at their most volatile last year, the Chinese market was actually quieter than many others. The CSI 300’s peak volatility level was the lowest of the four indexes, at 51%. The Nikkei had the highest spike, to 67%.

Given tight regulation, Andrew notes, China is unlikely to see an explosion of futures trading or dramatic changes in the way markets work anytime soon:

For now, futures trading is restricted to wealthy investors. And as Goldman Sachs points out, traders must post capital equal to 15% of their exposure to the CSI 300, compared with 9% for the S&P 500. That gives Chinese investors only about 60% of the leverage allowed with U.S. futures contracts. That means futures-trading volumes will likely remain low for a while. For the futures market to develop, China will need to relax rules further. Allowing foreigners to trade, for instance, would boost activity dramatically.

Some very useful thoughts, and something for any China investor to keep an eye on.

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